UK Court of Appeal clarifies whether lenders are on inquiry of undue influence in hybrid cases

Undue Influence; Barclays Bank plc v. O’Brien [1994] 1 AC 180 (“O’Brien”), C.I.B.C. Mortgages plc v. Pitt [1994] 1 AC 200 (“Pitt”) and Royal Bank of Scotland v. Etridge (No 2) [2002] 2 AC 773 (“Etridge”); Joint Borrowing; Constructive Notice; Section 199 of the Law of Property Act 1925.

Why should I read this?

It is not unusual for a lender to take security securing the lending to joint borrowers where some of the lending is used to repay one borrower’s debts only. The authorities (O’Brien, Pitt, Etridge (the “Authorities”)) support the proposition that (a) if the lending was a joint borrowing transaction, the lender is not put on inquiry of undue influence; and (b) if the lending is a surety transaction, the lender is put on inquiry.

However, Ms Catherine Waller-Edwards (“Ms Waller-Edwards”) submitted that, in a hybrid non-commercial loan situation (i.e. where some of the lending is used to repay one borrower’s debts (and is not for the benefit of both borrowers); and the remainder is used for the benefit of both), the lender is put on notice of undue influence unless the element of the transaction that is for the sole benefit of one borrower is trivial.

The Authorities do not deal with a Hybrid Case scenario, and so this case now serves as new guidance on the application of undue influence principles in the context of joint borrowing, which is particularly important for financial institutions and legal practitioners dealing with secured lending.

The Background

In 2011 Ms Waller-Edwards was experiencing a vulnerable period in her life. It was at this point that she met Nicholas Bishop (“Mr Bishop”) and began a relationship with him. At the time of meeting Mr Bishop, Ms Waller-Edwards lived in her own mortgage-free property with her two children, and had savings of over £150,000, together with a small income.

On 25 May 2012 Ms Waller-Edwards exchanged her property (then worth around £585,000) plus £150,000 to purchase a property that Mr Bishop had constructed (this being the property subject to the appeal). By the time of the completion of that transaction, Ms Waller-Edwards had been persuaded to accept two charges on the subject property.

The subject property was held in joint names subject to a declaration of trust providing that 1% was held for Mr Bishop and 99% for Ms Waller-Edwards.

In mid-2013 Ms Waller-Edwards and Mr Bishop approached One Savings Bank plc (the “Bank”) for a mortgage to be secured against the subject property. Whilst applying for a loan of £440,000, the Bank agreed to lend £384,000. As part of the mortgage transaction, Mr Clake of Ellis Jones Solicitors acted for all three parties (Mr Bishop, Ms Waller-Edwards and the Bank).

The Bank was told that the purposes of the loan was:

• to repay a previous charge of £200,000;
• to pay off a debt of £24,000 on Mr Bishop’s car finance (the “Car Finance”);
• to pay off a debt of £16,000 on Mr Bishop’s credit card (the “Credit Card”);
• to purchase another property using the remaining £142,000

However, this was untrue. Of the sum advanced, £233,801.76 was used to pay off the existing charge, the Car Finance, and the Credit Card; and the remainder was used to pay Mr Bishop’s ex-wife under the terms of settlement in divorce proceedings. Ms Waller-Edwards reaped no benefit from the sums paid to Mr Bishop’s ex-wife.

The Bank’s position was that it:

• understood that Mr Bishop and Ms Waller-Edwards wanted to remortgage their jointly owned property in order to repay an existing mortgage debt, purchase another property, and let out the subject property;
• did not know that Ms Waller-Edwards owned 99% of the equity in the property or that £142,000 was in fact being used by Mr Bishop to pay to Mr Bishop’s ex-wife as a divorce settlement;
• was aware that part of the loan would be used to settle the Car Finance and Credit Card (and this was in fact a condition of the mortgage offer);
• told the trial judge that it was not uncommon for a joint application to be made to consolidate debts and for debts to be in one party’s name. Indeed, Mr Bishop was the major wage earner in the home, and so it was not unusual for a lender to see debts in his name.

The loan was advanced and the legal charge was secured.

Subsequently, the relationship between Ms Waller-Edwards and Mr Bishop terminated. Mr Bishop moved out of the property towards the end of 2014 and ceased paying the mortgage instalments. The mortgage defaulted (by way of arrears and a breach of an obligation under the legal charge regarding personal residence) and in or around November 2021 the Bank commenced possession proceedings with a view to enforcing the terms of the legal charge.

Ms Waller-Edwards was the second defendant in the possession claim, and Mr Bishop was the first defendant. Mr Bishop did not defend the possession claim and was not involved in the subsequent appeals. Ms Waller-Edwards defended the possession claim on the basis that consent to providing the legal charge had only been obtained as a result of Mr Bishop’s undue influence, of which (it was said) the Bank was on notice. Ms Waller-Edwards sought to set aside the legal charge on the basis that the Bank was on notice of the undue influence and had failed take any steps to avoid being fixed with constructive notice.

The Trial

The first instance decision was granted on 8 December 2022 by His Honour Judge Mitchell (the “Trial Judge”). The Trial Judge found that the consent to the legal charge had been obtained by the undue influence of Mr Bishop but, in reliance on the Authorities, it was determined that the Bank was not on inquiry of the same, entitling the Bank to enforce the legal charge. The possession order was therefore granted.

The Trial Judge reached this decision by determining that £233,000 of the borrowing had been used to repay a joint debt (an existing charge on the jointly owned property), with only £39,000 (to the Bank’s knowledge) being used to repay debts in Mr Bishop’s name (which was a condition of advancing credit to the joint borrowers). It was adjudicated that the Bank had no prior knowledge of the reoccurring undue influence stemming back over the previous 12 months, or the declaration of trust and was therefore not on inquiry.

The solicitor acting for all three parties was also acting for Mr Bishop in his divorce proceedings and was therefore aware that c.£142,000 of the Bank’s advance was used to pay to Mr Bishop’s ex-wife. Ms Waller-Edwards argued that the Bank was on notice of the destination of the funds through that solicitor. The Trial Judge rejected the s.199 arguments on the basis that the solicitor representing the parties in dealing with the remortgage did not impute on any of the knowledge, regarding the intended destination of the funds, to the Bank. The solicitor had an existing retainer with Mr Bishop in dealing with the divorce and the exempting provisions under s.199 did not apply because the knowledge of the divorce did not arise in the context of the instruction to deal with the Legal Charge.

The High Court Appeal

Mr Justice Edwin Johnson handed down the decision on 27 September 2023.

The grounds for appeal were twofold:

• The Trial Judge was wrong to decide that the Bank was not put on inquiry in respect of the undue influence (“Ground 1”).
• Further or alternatively, the Trial Judge was wrong to reject Ms Waller-Edwards’ argument that the Bank was fixed with constructive notice of the undue influence by virtue of the operation of the exempting provision in section 199(1)(ii)(b) of the Law of Property Act 1925, on the basis that the solicitor was directed to make the £142,000 payment to Mrs Bishop, this knowledge was imputed to the Bank making this a surety case (“Ground 2”)

Mr Justice Edwin Johnson gave a thorough overview of the Grounds of Appeal and set out his reasoning as to why he rejected the Appeal.

As to Ground 1:

Mr Justice Edwin Johnson considered why the Trial Judge had reached the decision that he did and found his reasons to be sufficient to explain why he made his decision. The Trial Judge decided that this was not a surety case, this was clear from the fact that, to the Bank’s knowledge, the majority of the loan was being used to repay a joint liability. The debts owed by Mr Bishop and known to the Bank represented less than 10% of the loan total. It was determined that this was far from an Etridge scenario and therefore the Bank was not on notice. Whilst the Authorities did not specially deal with a Hybrid Case, it was said that the principles still applied in a scenario where most of the loan was used to repay joint borrowing.

As Lord Browne-Wilkinson explained in O'Brien, at 196E:

"a creditor is put on inquiry when a wife offers to stand surety for her husband's debts by the combination of two factors: (a) the transaction is on its face not to the financial advantage of the wife; and (b) there is a substantial risk in transactions of that kind that, in procuring the wife to act as surety, the husband has committed a legal or equitable wrong that entitles the wife to set aside the transaction."

A lender would only be on inquiry where the relevant relationship is a non-commercial one where there is no apparent benefit to the other party (in this case Ms Waller-Edwards). Mr Justice Edwin Johnson relied on Midland Bank plc v Greene [1994] 2 FLR 827 in support of this point and found that on the facts the Trial Judge had made the correct finding (notwithstanding the low threshold for inquiry on a mortgage lender) because on the face of it, this was not a case where Ms Waller-Edwards was simply acting as a surety to Mr Bishop. The Trial Judge was entitled to look at the re-mortgage as a whole.

Ground 1 was therefore rejected.

As to Ground 2:

On reflection, Mr Justice Edwin Johnson agreed with the Trial Judge that the instructions to deal with the re-mortgage stood apart from the retainer in place with Mr Bishop regarding the divorce and dealing with the payment to Mrs Bishop. The information obtained as part of the retainer with Mr Bishop, in relation to the divorce, could not be said to have returned when he was later instructed to deal with the re-mortgage, reliance was placed on Halifax Mortgage Services Limited v Stepsky [1996] Ch 207.

Further, it was agreed that the exempting provision in section 199(1)(ii)(b) of the Law of Property Act 1925 did not apply.

Ground 2 was therefore also rejected.

The Court of Appeal decision

The judgment was handed down on 28 March 2024.

The sole issue to be considered was voiced in a single question:

Is the lender put on inquiry unless the element of the transaction that is for the sole benefit of one of the borrowers is trivial?

Sir Geoffrey Vos determined that question of whether a lender is on inquiry as having to be viewed through the lens of the lender; the evidence established that an element of repaying a sole debt on joint borrowing is not unusual; the fact that, to the best of the Bank’s knowledge, only a mere 10% of the borrowing was to be used to repay the sole debts of Mr Bishop (which was a condition of advancing the credit to them both jointly) was not enough to turn this into a surety case as seen in Etridge, meaning the Bank was not on inquiry.

This decision provides clarity on the application of the principles from the Authorities in cases where only part of a mortgage loan is provided for the sole benefit of one of the two borrowers in a non-commercial relationship. Further, Lord Justice Peter Jackson specifically commented to say that such a test to assess whether or not the surety element of the lending was “trivial” would be “unduly onerous to lenders and to many borrowers.” He went onto comment that “the proposed redemption of personal loans of the principal earner was a restively routine incident of a remortgage of this kind…”

The Court of Appeal agreed with the High Court. The consensus being that the loan had to be looked at as a whole i.e. a joint borrowing made for joint purposes, regardless of an element of the re-mortgage repaying the debts of only one of the borrowers. This aligned with the substance of Lord Nicholls’ speech in Etridge.

This judgment is significant as it extends the principles from the Authorities to hybrid/partial surety cases, offering guidance for future cases where the loan functions as a joint advance for one part, while for the other part, the loan benefits one borrower with the other standing as surety. The case underscores the importance of the lender's awareness and the circumstances under which they may be deemed to have constructive notice of undue influence, potentially affecting the enforceability of a charge.

Practical considerations in respect of secured lending

• It is important to ensure that the purpose of the loan is recorded accurately. This case underscores the importance of a lender’s awareness of the relationship between the borrowers and the circumstances that may give rise to constructive notice of undue influence.
• This judgment has implications for the enforceability of a legal charge where undue influence is a factor, highlighting the need for lenders to exercise due diligence in certain transactions. This decision reinforces the necessity for lenders to be vigilant and to consider the dynamics of borrowers’ relationships when assessing the risk of undue influence.
• Banks are entitled to look at the lending as a whole. If joint borrowers are obtaining a secured loan for the benefit of only one borrower, a Bank will be on inquiry and should follow the principles as set out in Etridge to ensure there is no undue influence being applied by one borrower to another.
• By way of assistance to lenders going forward, helpfully Lord Justice Peter Jackson commented that:
  
  • “I could see the attraction of identifying cases where a lender is on notice by asking a single question, namely whether there is any aspect of the transaction that should indicate to the lender that the transaction as a whole might not be to the financial advantage of one of the borrowers…that approach, would lead to the same result in the present case”
  • With this comment in mind, it might be prudent for lenders to look at their application questions to see if more could be asked of joint borrowers to protect the Bank from later arguments regarding undue influence.

Further or associated reading

• Barclays Bank plc v. O’Brien [1994] 1 AC 180
  
• C.I.B.C. Mortgages plc v. Pitt [1994] 1 AC 200
  
• Royal Bank of Scotland v. Etridge (No 2) [2002] 2 AC 773
  
• Midland Bank plc v Greene [1994] 2 FLR 827
  
• Section 199 of the Law of Property Act 1925
  
• Halifax Mortgage Services Limited v Stepsky [1996] Ch 207
• High Court Decision – Waller-Edwards v One Savings Bank PLC [2023] EWHC 2386 Ch
  
• Court of Appeal Decision - Waller-Edwards v One Savings Bank PLC [2024] EWCA Civ 302